U of Ideas of General Interest ó July 1998
University of Illinois at Urbana-Champaign
Contact:
Mark Reutter, Business & Law Editor
(217) 333-0568; [email protected]
THE NUMBERS GAME
Poor-performing firms tend to keep high CEO pay from stockholders
CHAMPAIGN, Ill. ó When in doubt, fudge. That was the pattern of at least one in five large publicly traded companies when asked in 1993 to justify the paychecks of their chief executives based on company performance, a team of University of Illinois researchers has found.
If a CEO was paid well and the company performed poorly, this information was apt to be dodged in proxy statements required by the Securities and Exchange Commission. ìOrganizations have been shown to be quite ingenious in packaging their accounts and rationalizations for delivery to external constituencies,î Joseph Porac, James Wade and Timothy Pollock wrote in a forthcoming paper in the Administrative Science Quarterly. Similar results were found in 1994 proxy statements.
In 1992, the SEC enacted reporting rules that required corporate boards to justify CEO pay with explicit performance comparisons between their company and a peer group of firms that the board was allowed to select on the basis of line-of-business similarities. The comparisons were supposed to clarify to stockholders how well CEOs performed for their pay. The SEC hailed the new rules as ìthe best protection against abuses in executive compensation.î
How well have the rules worked in practice? The U. of I. professors did a computerized analysis of more than 15,000 sentences and statistics devoted to CEO pay and company performance by 280 firms on the Standard & Poor 500. Almost half (47 percent) of the boards used widely accepted industrial indexes to situate their comparisons of peer companies, while another 28 percent blended two or more published industry indices to arrive at a composite comparison.
However, 24 percent of the boards picked a ìcustomizedî class of companies by which to make their comparisons, and 19 percent used half or fewer of the firms within their primary industry. In discussing how they came up with the comparisons, the same boards tended to devote significantly less editorial space than the boards using more widely accepted data.
All of which raised questions as to the quality of data that the stockholders received. After controlling for such factors as company size (larger companies pay more), CEO tenure (older ones get more) and level of diversification, Porac, Wade and Pollock still found that the greater the bossÃs pay, the more a board went outside the firmÃs natural peer group to make the performance comparisons.
Equally striking, the companies most likely to customize their proxy comparisons were those with the most activist stockholders. This surprised the authors, because informed and vocal stockholders, according to the SEC, are supposed to act as a check on boardroom behavior.
ìOur findings suggest that rather than opening up the CEO pay process, the SEC rules have had the unintended consequence of creating new opportunities to politicize it,î Pollock said. ìIn an attempt to minimize shareholder resistance, some companies appear to manipulate the data.î
-mr-
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